Federal Partnering and Performance Incentives to Spur Efficiency in the Water Sector

The Performance Infrastructure Review Committee (PIRC) is an informal group of policy and finance specialists focusing on new financing tools that would promote more efficient infrastructure investments. The Committee recognizes that there are fundamental issues relating to revenue streams, governance, and institutional design being evaluated by groups such as the National Academy of Public Administration and the Bipartisan Policy Center. The April issue of Public Works Financing contained several articles describing some of PIRC’s recommendations for financing tools at the federal, state and local levels. This month’s article, written by David Seltzer of Mercator Advisors and Judson Greif of Greenfield Government Strategies, expands on PIRC’s grant incentive mechanism to encourage enhanced efficiency in the nation’s community water sector.”It is hoped that PIRC’s analysis will be of assistance to the Administration and Congress as they formulate new policies to stimulate infrastructure investment.

America’s drinking water and wastewater sector is incredibly fragmented. There are 51,000 community water systems and 16,000 community wastewater treatment systems nationwide. The vast majority are small systems serving fewer than 10,000 people. Their small scale results in a number of challenges, including difficulty in accessing capital for the nearly $100 billion of system renovations EPA estimates will be needed over the next two decades, operational and procurement inefficiencies, and problems in meeting federal and state water quality standards.

Partnering in some fashion with a larger entity could overcome many of these problems. However, there are various governmental impediments hindering such efforts. At the local level, there may be inertia or even aversion to changing the status quo. In many states, Public Utility Commission (PUC) regulatory policies prohibit including developer-donated and grant-funded assets as part of the rate base for cost recovery. At the federal level, the tax code restricts tax-exempt private activity bond financing due to state volume caps and costly rehabilitation spending requirements.

The PIRC recommends a series of federal policies designed to encourage greater voluntary partnering within the water sector to help overcome these challenges. These restructurings could take a variety of forms. In some cases, a small municipally- or privately-owned system may wish to align with an existing regional public water agency. In other cases, the best solution may be to out-source operations to a larger operator, or even sell the system to a private or governmental utility. The range of potential partnerships and combinations is illustrated below.

Federal Policy Incentives

The federal government could use a suite of policy tools—regulatory reforms, grants, credit assistance and tax code incentives—to incentivize community water and sewer systems to improve performance through partnerships, long-term lease concessions, or other arrangements (see A-E below). PIRC’s performance-based proposal is agnostic on the issue of public vs. private system operation and ownership.

A. Provide Federal Partnering Incentive Grants

A new federal grant program is proposed, administered by EPA and distributed through each State Revolving Fund (SRF) for drinking water and wastewater restructurings. The program contemplates federal grants equal to 20 percent of the acquisition price or water system asset value, subject to a nationwide cap on total assistance of $1 billion per year over 10 years, or $10 billion in total.

The incentive grants would be applied as follows:

• System Remediation: 75% of the grant proceeds would be designated for improvements to the system assets being conveyed or outsourced, as well as that system’s pro-rata share of any common use assets (e.g., filtration and treatment plants). The SRF would require the acquirer or new manager to develop and periodically update a Utility Asset Management Plan for repairing, maintaining and renewing the infrastructure of the acquired system. In order to ensure the system’s ongoing performance, the grant conditions would stipulate that the operator set rates each year at the “true cost of service,” which means a level sufficient to fund both operations and routine maintenance as well as any required capital renewal.

• SRF Projects: The SRF would be permitted to use 25 percent of the grant for projects anywhere within the state for grants or loans for other water infrastructure projects, as well as outreach, training and technical assistance to community water systems considering restructuring. The SRF could also reimburse itself for the administrative costs of the program.

There would be no federal restriction on how the public or private entity that sold or long-term leased its system could use the net proceeds. The chart below illustrates the proposed flow of funds:

B. Waive EPA Fines and Liability of Serious Violators Upon Merger

EPA could adopt regulations allowing smaller systems that are seriously out of compliance with EPA water quality standards to avoid enforcement action by agreeing to an outsourcing contract or merger with a larger system that has the demonstrated ability to make the necessary investments to meet EPA standards.

C. Allow Private Operators Access to SRF

Congress should expand eligibility for Clean Water SRF loans to private companies serving the general public, similar to the Drinking Water SRF Program.

D. Liberalize PAB Rules for Water and Sewer

Federal tax law should allow public-use privately-managed facilities to access the tax-exempt bond market unencumbered by the PAB volume cap. In addition, PABs should be made exempt from Alternative Minimum Tax (AMT); the rehabilitation spending requirement for used property acquisition should be made consistent with the test for buildings (e.g., 15% rather than 100% of PABs); and any outstanding tax-exempt debt should be allowed to remain outstanding after a change in ownership without losing its tax-exempt status.

E. Make Federal Credit available for Water Consolidations

Low-cost Federal loans should be made available to help finance small system acquisitions through expanding the size and scope of the WIFIA credit program.

Conclusion

Establishing federal policy incentives for partnering, regionalizing or consolidating the widely fragmented water industry should provide multiple benefits to the various stakeholders. For drinking water and wastewater system customers, it should lead to economies of scale in operating expenses, cushioning user rates. For the municipal water system owners, it should result in net proceeds to their General Fund while generating grants for improvements to the community’s system. SRFs would receive grants to fund both outreach and additional projects statewide. And for the public at large, it should help conserve water resources, improve public health and enhance the environment.